Executive Summary
  • Business owners and their professional advisors should review corporate agreements to ensure buy-sell provisions are not out of date and will work as intended.
  • Common traps related to the valuation process and buy-sell agreement language – which often lead to costly shareholder conflicts – are highlighted in a recent appellate court decision.
  • Using an appropriate valuation date and premise of value is crucial in times of business disruptions or market volatility, such as with the novel coronavirus.

In a concise opinion, the Court of Appeals in Indiana recently clarified a key point in shareholder buyouts. Buy-sell agreement issues are at the heart of many of these buyout conflicts. Following are three related, and unfortunately common, buy-sell problems from a business valuation perspective.

  1. Unclear Standard and Premise of Value
  2. Inflexible and Untimely Valuation Date
  3. Confusing or Inadequate Valuation Process

The primary issue in Hartman v. BigInch was whether, “the value of shares under a buyback provision in a Shareholder Agreement can be discounted for lack of marketability and control when the Company is required to purchase the shares.”

The Shareholder Agreement required the Company to purchase the shares of any shareholder who is involuntarily terminated as an officer or director of the Company.  Pursuant to the provisions of the Shareholder Agreement, this purchase must be made at “appraised market value on the last day of the year preceding the valuation, determined in accordance with generally accepted accounting principles by a third-party valuation company.”[1]

It is remarkable how many potential pitfalls were packed into the short segment of the agreement quoted in this case. Following is a breakdown of the three problems listed above.

Unclear Standard and Premise of Value

In 2001, five appraisal organizations united in publishing the International Glossary of Business Valuation Terms (IGBVT).[2] However, nearly 20 years later, many buy-sell agreements still use imprecise terms such as, “appraised market value,” without further necessary clarification.

According to the IGBVT, a standard of value is, “the identification of the type of value being utilized in a specific engagement; e.g. fair market value, fair value, investment value.”

  • Fair market value[3] is based on the perspective of hypothetical investors, is applicable for most tax valuation engagements, and typically includes consideration of discounts for lack of control and marketability.
  • Fair value is defined for financial statement reporting purposes in FASB ASC 820[4] and often resembles fair market value, with situational differences beyond the scope of this article.
  • Investment value is defined by the IGBVT as, “the value to a particular investor based on individual investment requirements and expectations.”

For shareholder buyouts, fair value is defined by state statute or case law, which varies state by state, but is generally based on the principle that shareholders should be fairly compensated (i.e. one party should not gain a windfall at the expense of another in a shareholder buyout). In practice, fair value for an ownership interest often resembles a pro rata or undiscounted portion of the fair market value of the whole business.

Business man signing contract
Photo by Andrea Piacquadio

As noted in the Hartman v. BigInch appellate ruling, “a wide majority of courts in sister states have regularly rejected the application of control and marketability discounts to situations where a shareholder is compelled to sell to the majority.” Otherwise, shareholders have broad discretion to craft their buy-sell agreements, with a range of valuation definitions and provisions at their disposal.

Care must be taken to balance shareholder goals for fairness in a potential buyout with other business succession and tax planning objectives. For example, arms-length transactions among shareholders should be considered and may impact valuations for tax purposes under fair market value.

Premise of value is defined in the IGBVT as, “an assumption regarding the most likely set of transactional circumstances that may be applicable to the subject valuation; e.g. going concern, liquidation.”

  • Going Concern Value is defined in the IGBVT as, “the value of a business enterprise that is expected to continue to operate into the future. The intangible elements of Going Concern Value result from factors such as having a trained work force, an operational plant, and the necessary licenses, systems, and procedures in place.”
  • Liquidation Value is defined in the IGBVT as, “the net amount that would be realized if the business is terminated and the assets are sold piecemeal. Liquidation can be either ‘orderly’ or ‘forced.’”

If a business is distressed, or in times of significant market volatility, the premise of value can have a large impact on the valuation of a business. This should be addressed and built into a buy-sell agreement as well, to avoid costly disputes at a time when financial resources are most likely to be strained. Issues around premise of value will be highlighted further in the following section, as they closely relate to selection of the valuation date for shareholder buyouts.

Inflexible and Untimely Valuation Date

In our subject case, the agreement specified a value to be determined, “on the last day of the year preceding the valuation.” This is a common provision, likely because year-end financial statements and tax return documents are presumed to provide a greater level of reliability as compared with internal mid-period financial statements.

An inflexible valuation date in a buy-sell agreement leads to a big risk though. What if there have been major changes in the business or market environment since year-end?

The timeline of the novel coronavirus shutdown in early 2020 is a direct example of this risk. A shareholder, desiring to exit a distressed business that is struggling due to this situation, could attempt to reap a windfall in mid-2020 by triggering a buyout based on a December 31, 2019 valuation. A prior year-end valuation provision could also be required in the event of death, disability, or other trigger events that happen later in the following year, potentially leading to undesirable tax and wealth distribution consequences.

In a distressed or unprofitable business, value may be higher on a liquidation premise than on a going concern premise. This can lead to conflict if the parties disagree on continuing to operate the business.

Buy-sell provisions based on year-end valuations may be reasonable in stable times. Flexibility on the valuation date can be incorporated with clauses that provide for a more current valuation date in the event of material changes in the business or market environment since the prior year-end. In addition, owners should consider what premise of value will apply if the business is in distress. The terms under which price will be paid should be clearly stated as well, whether funded with insurance, a promissory note or full cash payment within a specified period.

Confusing or Inadequate Valuation Process

Some buy-sell agreements specify that the valuation should be performed by the company’s accounting firm. Unfortunately, this leads to a potential independence issue or conflict of interest. If the accounting firm performs an audit of the company’s financial statements and the buy-sell transaction impacts those statements, the firm would have an independence problem. An accounting firm also risks – whether in appearance or in fact – a potential conflict of interest with multiple clients all party to the agreement.

The agreement cited in the Hartman v. BigInch case avoided the above problem by specifying that a third-party valuation firm should be employed. However, it said the valuation should be, “determined in accordance with generally accepted accounting principles.” The problem is that generally accepted accounting principles are not a valuation standard. Third-party valuation firms are generally not in the business of issuing opinions on financial statements. A relevant requirement would be for the valuation to be prepared in accordance with the Uniform Standards of Professional Appraisal Practice, the AICPA’s SSVS-1 Statement on Valuation Standards, or other applicable valuation credential-related standards.

Beyond simply stating a third-party valuation firm will be used, the qualifications of the appraiser should be clarified. Are valuation credentials required? What about some minimum number of years of valuation experience? Is industry-specific experience necessary? By clarifying these points upfront, all the parties to a buy-sell agreement can gain confidence in the outcome of the valuation process.

There are many appraisal mechanisms used in buy-sell agreements, such as multiple appraiser processes, formulas, or cross-purchase shotgun approaches, among many others. A consensus best practice observed within the valuation profession is to select a single appraiser or valuation firm and value the business upon creation or revision of the buy-sell agreement.

An initial valuation should be followed by periodic updates, which assists in strategic business and personal financial planning, engages a regular meeting of the minds among owners, and ensures buyout funding mechanisms are appropriate for changing values. Frequency of these updates may vary from every two to three years for smaller stable businesses, to annually, or even more frequently in the case of a rapidly changing business with many shareholders.


Buy-sell provisions should be reviewed regularly, especially when there are changes in ownership dynamics or in the business environment. Combining insights from both an attorney and business valuation expert in creating or revising such agreements will reduce conflicts, confusion, and costs when the agreement inevitably comes into play. This is a case where an ounce of prevention really is worth a pound of cure.

About the Author: Brian M. Alwine, CPA, ASA has 20 years of experience in business valuation. He has worked with hundreds of clients across the USA, ranging from small privately held companies to large public companies in many industries. Brian is a Director with Redwood Valuation, a boutique business valuation firm with a focus on serving venture capital and private equity clients nationally. More information is available at www.redwoodvaluation.com.


[1] https://www.in.gov/judiciary/opinions/pdf/05052001par.pdf

[2] https://www.nacva.com/content.asp?contentid=166

[3] Fair Market Value is defined in the IGBVT as, “the price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.”

[4] https://asc.fasb.org/imageRoot/00/7534500.pdf

Lead photo by Maarten van den Heuvel on Unsplash